Creeping Shadows: Now China’s Brokerages Are Making Loans

Having trouble borrowing from the banks? Or trusts? Or pawn shops, underground lenders, wealth management products, corporate finance companies, or small-loan companies? Don’t worry. China’s securities companies are also in the loan game.

It would seem that there is no shortage of avenues through which to tap credit these days in China. If anything, mounting debt levels, fueled by the shadowing banking sector, is raising concerns that credit is being dispensed too freely.

Zuma Press

Into this step China’s brokerages. According to local media, as of February, 75 of them were allowed to make loans that are backed with shares as collateral – a practice akin to margin lending.

The scope of activities that securities companies are allowed to engage in has been greatly expanded over the last 18 months. Traditionally their business has been dominated by underwriting initial public offerings and providing brokerage services for people trading shares. But public interest in stocks hasn’t rebounded since the market collapsed in 2008, and the regulator has suspended IPOs since late last year.

But recent changes in regulations have allowed them to move into wealth management, margin trading and securities lending – and securities-backed lending.

Securities-backed lending – whereby a brokerage buys a customer’s shares at a discount, but promises to sell them back at a set date – was launched at the end of 2011, when three firms were allowed to make loans on a trial basis. By August 2012, the trial had been expanded to more than 10 firms, according to the Shanghai Stock Exchange. Local media reported that in early February almost 40 brokerages were cleared to lend, taking the total to 75.

There’s very little data available on the extent to which the securities firms have embraced the new service. But given that until recently only a handful them had been allowed to do it, it’s fair to assume overall lending levels remain small.

China Galaxy Securities Co., which was one of the firms involved in the original trial, said in listing documents provided recently to the Hong Kong Stock Exchange ahead of its planned IPO (pdf), that “the aggregate outstanding balance of securities-based lending product” at the end of last year was only 648 million yuan ($105.4 million), up from 6 million yuan at the end of 2011.

That’s small, but given it’s cheaper than other kinds of debt, demand could grow quickly.

The Shenzhen branch of Huatai Securities Co. is advertising its lending rates as between two and three percentage points above the central bank’s benchmark one-year lending rate, which is currently 6.15% (in Chinese). Huatai says that’s significantly lower than rates charged by pawn shops, which it puts at 4% monthly, and trust companies, which are over 10% annually. Huatai says it is willing to lend 70% of the value of the shares.

Securities firms can afford to offer lower rates because, of all the non-bank lending avenues that have proliferated in recent years, this one is relatively low risk. If the borrower fails to pay, the securities company can sell the shares, which are a lot easier to exchange for cash than property – which is what trust companies typically demand as collateral – or cars and jewelry, which pawn shops often hold as security.

That’s also why it is a popular form of borrowing elsewhere in the world, sometimes among people who need funds but have less-than-stellar credit ratings. The lender doesn’t need to worry about whether the borrower is going to make good on the loan when the shares can be liquidated at a moment’s notice.

Given that borrowers need to hold as least 2.5 million yuan worth of stocks to be able to borrow, in China customers are likely to be companies and wealthy individuals. Many institutions and firms that invested in listed companies prior to IPO aren’t allowed to sell their shares up to three years after listing, so this could be a way to put to work funds that are locked up.

“The securities-based lending product helps our clients obtain desired liquidity without a fire-sale of their securities and also offers them opportunities to mobilize their idle assets,” Galaxy Securities says in its listing documents. “Subject to regulatory requirements and restrictions, we plan to gradually expand the variety of our securities-based lending product to better meet clients’ financing needs.”

One constraint on the business’s growth, however, is that the securities companies are required to hold capital against the loans, much in the same way as banks. Moreover, there are increasing demands on brokerages’ capital.

Galaxy Securities says that some of the funds raised from its IPO will go toward expanding its securities-backed lending, but its priority is clearly margin trading and securities lending, for which about 60% of the IPO proceeds are earmarked.

But securities companies could fund their lending by packaging the loans as wealth management products. That could help preserve the securities companies’ capital, while offering a high return and relatively low risk investment to savers. And for securities companies that currently have little to distinguish their wealth management offerings from those of the trust companies, it could provide a much needed point of differentiation.

Of course, it’s still early days yet, and the volume of lending barely registers as a blip on the amount of new credit created each month in China. But given that securities firms have a huge customer base and thousands of branches throughout the country – Galaxy Securities alone boasts more than five million customers and almost 300 branches – they have a much broader reach than the hugely successful trust sector. Securities lending could be an area to watch.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.